9.26.2011

Credit markets, unique identifiers and biometrics

Once in a Starbucks I met a guy who worked in the US credit-rating industry and he told me that one of the biggest under-stated issues in the credit market was the miss-assignment of credit penalties because individuals have the same name (sorry, John Smith). He instructed me to go and check my credit scores to make sure the rating agencies weren't assigning me penalties that were due to someone else's failure to repay a loan (but given my name, I wasn't terribly concerned). However, I was completely stunned, given the state of technology, that we still rely on names to uniquely identify people.

The same issue hold in poor countries, except it's exacerbated by weaker credit-rating institutions and greater difficulty tracking individual people. This recent NBER working paper illustrates the importance of unique identification for credit markets and demonstrates how biometric technologies can help.

Abstract: We report the results of a randomized field experiment that examines the credit market impacts of improvements in a lender's ability to determine borrowers' identities. Improved personal identification enhances the credibility of a lender's dynamic repayment incentives by allowing it to withhold future loans from past defaulters and expand credit for good borrowers. The experimental context, rural Malawi, is characterized by an imperfect identification system. Consistent with a simple model of borrower heterogeneity and information asymmetries, fingerprinting led to substantially higher repayment rates for borrowers with the highest ex ante default risk, but had no effect for the rest of the borrowers. The change in repayment rates is driven by reductions in adverse selection (smaller loan sizes) and lower moral hazard (for example, less diversion of loan-financed fertilizer from its intended use on the cash crop).